Euro zone’s best growth days may already be in the rear-view mirror

August 21, 2015

The latest euro zone flash purchasing managers’ indexes may have surprised slightly on the higher side, but many are still not convinced that better economic growth is coming later this year.

Commerzbank, Capital Economics, and ING, to name a few, acknowledged the positive surprise but were reluctant to suggest it was anything more than just temporary relief from a generally-weakening outlook for global growth.

The European Central Bank’s massive bond buying programme – worth 60 billion euros a month – and a currency that originally lost around 20 percent against the dollar made local goods cheaper, stimulating the economy particularly in the run-up to the ECB’s purchases, which started in March.

The first signs of a pickup in growth were late last year, propping up euro zone PMIs from March through June this year, which was a recent high.

The Flash Composite PMI for August rose again after a small setback in July to 54.1 from 53.9. But that is still low when compared to boom times before the financial crisis in 2006/07.

EZ PMI - Commerz

Euro zone growth in the second quarter was just 0.3 percent. The latest Reuters poll predicted it would improve to 0.4 percent over the next two quarters (including the current one) but not get any better from there.

Markit said at least the latest PMI suggests that 0.4 percent pace will be met. But not all analysts are convinced it will be.

“Despite massively lower energy prices and the weak euro, the economy in the euro zone only expanded modestly in H1. And the prospects for H2 are no better,” wrote economists at Commerzbank. “It is likely that majority of analysts and the ECB, which expect growth to accelerate, will soon revise their growth forecasts for this year downwards.”

Maintaining the current growth rate – and certainly any hope for improvement – is at risk from the economic slowdown in China, which is only now becoming apparent to many investors as real and likely to get worse.

Europe and China’s trading relationship is important for both countries. If China slows down further, that puts more burden on domestic demand in Europe to pick up any slack. And while there have been some signs of improvement recently, nobody is forecasting a burst of pent-up demand just around the corner.

Barclays headlined in a note that Europe’s flash PMIs were “yet to be affected by China woes,” implying that they might well do quite soon given that most of China’s other trading partners, particularly in Asia, are already feeling it.

To make matters worse, the euro has recovered a good deal of its lost ground which means any potential benefit from that weaker currency is now less potent. And now China has devalued the yuan.

“We still see euro-zone growth slowing in the coming months as earlier boosts from falling inflation and the euro’s depreciation fade, particularly if renewed uncertainty surrounding the Greek election damages confidence,” wrote economists at Capital Economics. 

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